A view from the Bridge - August 2023

The Bank of England raised base rates by 25bp to 5.25% last Thursday, in line with a recently revised consensus, which had been broadly split between 25bp or 50bp, prior to the softer inflation and growth data over the past couple of weeks. The Monetary Policy Committee was split 6-2-1 in its decision, with two members (Mann & Haskel) voting for 50bp and one member (Dhingra) voting for unchanged rates. Megan Greene voted for a 25bp increase at her first policy meeting, Ms Greene replacing Silvana Tenreyro who had previously voted to keep rates on hold. This was the first three-way split in the policy vote since last year and is indicative of the MPC getting close to an inflexion point after fourteen consecutive hikes (1x 15bp, 7 x25bp, 5x50bp and 1x75bp) and 5.15% of cumulative tightening since December 2021. Following last month’s better than expected inflation data it is concern over wage growth that is now the primary driver. However, although wage formation has been surprising to the upside against bank forecasts, there are clear signs that some labour market slack is emerging with job vacancies declining relative to the unemployment rate, which has ticked up.

The financial media have naturally followed today’s hike and subsequent press conference with commentary suggesting that Governor Bailey and the MPC remain highly vigilant against inflation and may continue to hike further. However, buried within the detailed text of the committee’s deliberations there are clear signs that even the most hawkish members of the committee felt that a 50bp increase to 5.5% could have prevented the need for much further tightening in monetary policy. Therefore, we have more confidence now that base rates peak at or below 5.75% with a pause at 5.5% becoming the most plausible scenario if the wage data plateaus and inflation data continues to moderate over the next couple of months. After today’s announcement we saw 3mth SONIA futures imply a base rate peak of 5.75% around February next year, down from 6.5%-6.75% in early July.

It won’t be lost on seasoned market participants that 5.75% was the peak in base rates under BOE Governor King in July 2007 (they hit 6% under (the late) Sir Eddie George in February 2000), so there is an eery coincidence to the market implied summit during this cycle. We would emphasise it is more coincidence than systematic given that economy’s equilibrium growth, inflation and employment metrics have changed considerably since 2007. Nonetheless, it shows the extent of tightening that has been implemented by the BOE to bring down the post pandemic spike in inflation given that economic growth indicators have remained quite moribund. Over the coming months we expect the conversation amongst market participants to shift back towards the duration of rates being held at their peak and/or when the first easing of policy could occur. It’s worth bearing in mind that of the 14 consecutive hikes, we have probably only experienced about 5-6 of them in terms of their lagged impact upon demand and supply in the economy, the last 8-9 hikes have added 3.75%-4% to floating rate borrowing costs, so it’s worth considering this is yet to fully impact the economy via fixed rate mortgage and commercial debt refinancing. It is this delayed tightening effect that can still cause the BOE to pivot towards easier policy quite quickly if the wage and inflation data were to soften more rapidly into early 2024.